Maxine Udall (girl economist)

Structural Misalignment and a Counterfactual Economy

Paul Krugman weighs in on the structural unemployment debate here , here, here, and most recently and comprehensively here. Here are two excerpts from two recent blog posts:

Claims that there has been a huge jump in structural unemployment — that is, unemployment that can’t be cured by increasing aggregate demand — are playing a large role in the argument that we should basically do nothing in the face of a terrible economy. No need for the Fed to do more; no need for more fiscal stimulus — hey, it’s all about defective labor markets, and we should work on structural reform, one of these days. And don’t expect improvement for years to come. Structural unemployment is invoked by Fed presidents who want to raise rates, not cut them, by economists who want austerity now now now, and in general by almost everyone in the pain caucus.

Legend aside, this is not mainly about displaced construction workers — and there are no other dying industries to point to. Lousy labor markets span the country, except in a handful of states with almost no people. It’s a terrible job situation for college graduates as well as high-school graduates.The idea that this economy is primarily suffering from mismatch is simply bizarre.

First let me say that I agree with Krugman in the essentials, but I find myself wondering if we can be confident that there really is not a larger structural problem embedded within the obvious acute problems of high unemployment and depressed aggregate demand? For example, suppose that there have been massive and pervasive distortions of human capital and labor and other markets resulting from massive distortions in or induced by financial markets. Suppose those distortions lasted at least 10 years and maybe a long as 30 years. Then many sectors of the economy and the workers in them have been shaped by the distortions in ways that may be difficult to discern.

The fact that the financial sector's share of GDP has grown so dramatically over the last 30 years suggests that other sectors have lost out in terms of the growth and productivity they might otherwise have delivered to the benefit of us all. A massive drain such as this must have affected both physical and human capital in those sectors as well as affecting the larger economy we would otherwise expect to see. Unfortunately, we have no way of knowing what is the conterfactual economy we would have observed without the bubble(s). (Note that if George Soros is correct and the last 30 years have been superbubble, then I think the effect I'm trying to describe is even more entrenched and difficult to detect.)

If my conjecture is right, might an economy, shaped by persistent and pervasive distortions in combination with a massive downturn and tightened credit, be characterized by no new and thriving sectors requiring new workers with new skills (because much of the capital that would have fueled them has been siphoned into contingent markets and housing) even as the existing sectors and workers languish? Could there be a larger structural problem, but we can't see it because the economy has been so distorted? 

My point here is that Krugman is right (as usual) that there is no evidence consistent with structural unemployment, but are we missing something bigger? A perspective perhaps that would argue that we have something worse than short-term structural unemployment such as we might see in an economy characterized over the long-term by well-functioning markets and by rapid progress and growth, at least in some sectors other than finance. What if the misalignment is so long-standing and has been so destructive to real innovation and productivity that real growth and innovation have been effectively squelched in many sectors? Perhaps not everywhere and always, but enough that now when we look for signs of structural unemployment as Krugman has done, we find no indication of it because sectors where there might have been innovation and growth that would now be demanding workers with different skills, were not able to compete effectively for capital? As I write this, I think this can't really be possible. Even crippled markets would allocate some capital correctly, yes?

The beauty of capitalism and commercial exchange when they work is that they coordinate, communicate and equilibrate the demand for and supply of capital, human, financial, and physical, to those places where productivity is highest and output most valued.  The false signals of bubbles do the exact opposite. Instead of producing growth in new technology, in new and better products, and in new jobs, our recent bubble most likely produced underinvestment in human and other forms of capital not directly beneficial to Wall Street along with immense amounts of unsecured risk, granite countertops and en suite baths.

I find myself asking, what would our and the world economy look like if Wall Street had been doing it's job? If I'm right, they would be dramatically different. In that case, as Krugman points out there is no mismatch between the jobs of that distorted economy and the skills of the workers who have been working in the economy that we have. If I'm right, the mismatch is between the workers of the economy we have and the workers of the economy we want and need to have to set us back on the counterfactual trajectory of more diverse growth and productivity; the counterfactual economy we would have had if Wall Street had been doing it's job. If I'm right then we have a major structural problem and I don't think anyone will be able to argue credibly that government should be shrunk and drowned in a bathtub. If it took years of misplaced private sector "enthusiasm" to create the misalignments, it will almost certainly require government to take a larger role in righting them. Thank you, Wall Street.

Let me make my case.

Earlier this year I observed that the price of casino-like finance is higher than we think. Specifically, not only did it siphon off trillions of dollars that created a surplus of homes and commercial real estate, not only did it siphon equity out of existing homes and transform it into bigger, more expensive cars and pickup trucks, and RVs, along with extra baths and state of the art kitchens that may or may not recoup value for homeowners, it also siphoned talent into the financial sector (and into the construction sector).

Now I’m going to ask you to imagine the counterfactual of the world in which the housing bubble occurred. Imagine that over the last 20 or so years our future mathematicians, social and physical scientists, and social workers had left undergraduate or graduate school in a world in which the financial sector had not become so large, so distorted by short-term private incentives, and therefore so personally lucrative. Moreover, imagine a world in which capital had not been siphoned to housing and real estate, but instead had been allocated (as we in the economics profession like to believe it will be) to those areas of the economy where potential returns to capital are highest, where technology is advancing (and presumably yielding benefit to us all). In the counterfactual world, the efficient allocation of capital would have blazed the efficient, productive trail into the steadily improving future we have for the most part observed since Adam Smith and others first noticed that the division of labor and the willingness of the owners of capital to seek its highest return appeared to take us all to something that was better than feudalism.

Now ask yourself: In that counterfactual world, where the financial sector was doing what it is supposed to do, what would the economy have looked like? Where would have been the jobs? How would individuals have adjusted their investment in human capital in order to increase their competitiveness for the counterfactual jobs? How would investors have invested? What would manufacturers have produced?

I believe that the answers to these questions tell us something about the nature of unemployment we are facing now and the policy options that are likely to drive us out of the (shallow thanks to the stimulus) unregulated-finance-sector-induced crater we find ourselves in.

The financial sector has muddied the waters for many years, not just the last quarter or two, signaling reductions in risk and returns to financial, physical and human capital that were highly distorted in many cases and that have consequently created large discontinuities in the demand for and supply of all types of capital and, consequently, in supply and demand in goods and services markets. The net effect in labor markets is that we now have a good match between skills and the jobs in the economy we used to have, but we may not have a good match between skills and jobs in the economy we could have had or the economy we would like to have. This is a structural problem, but not one that is likely to fix itself without some major restructuring in which the government and government policy must take active roles. Thank you, Wall Street.

If I'm right that we have a long-term structural problem, it will require remedies and restructuring that benefit more than the top 1% of wage earners. For this reason, shrinking government, while simultaneously refusing to stimulate aggregate demand, will almost certainly make the recession longer and deeper. On the other hand, stimulating aggregate demand in ways that preserve the old economy rather than reshaping it to produce the human and physical capital and public infrastructure that the counterfactual economy would have given us will only leave us mired in a dysfunctional economy.

Either way, when the private sector has been the problem, it's hard to imagine an effective solution that doesn't involve a safety net that includes health insurance combined with government action aimed at strategically boosting aggregate demand by targeting those most at risk and most likely to spend while also adopting public policies aimed at remedying the gross distortions in capital markets, human, physical, and financial, over the last 30 years.

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Krugman's response, a clarification with which I am in full agreement, here.

Private Sector Efficiency?

Mark Thoma sends us to this Washington Post article about an apparently low-paid private sector employee who has been signing off on GMAC mortgage foreclosures at the rate of roughly 10,000 per month with little regard for the accuracy of the documents he was signing.

...as the leader of the document execution team for GMAC Mortgage. He has signed off on as many as 10,000 foreclosures in a month, according to court documents. That's barely a minute per case, assuming he works a normal eight-hour day.

His signature indicated that the information in the cases was accurate to the best of his knowledge, and that he had signed in the presence of a notary. The problem was, that didn't always happen, according to depositions that Stephan gave in December and June for court cases involving families trying to keep their homes.

Stephan's admission has cast into doubt thousands of mortgage foreclosure filings. Ally Financial, the nation's fourth-largest home lender and GMAC's parent company, halted evictions of homeowners this week in the 23 states that mandate a court judgment before a lender can take possession of a property.

Calculated Risk sends us to this article about a Florida man whose house, bought and paid for with cash, was foreclosed on by Bank of America.

When Jason Grodensky bought his modest Fort Lauderdale home last December, he paid cash. But seven months later, he was surprised to learn that Bank of America had foreclosed on the house, even though Grodensky did not have a mortgage.

Grodensky knew nothing about the foreclosure until July, when he learned that the title to his home had been transferred to a government-backed lender. "I feel like I'm hanging in the wind and I'm scared to death," said Grodensky. "How did some attorney put through a foreclosure illegally?"

Bank of America has acknowledged the error and will correct it at its own expense, said spokeswoman Jumana Bauwens.

The same article describes one real estate agent's attempt to halt a foreclosure because she had a buyer. Unable to halt it, the bank foreclosed and is now listing the property for less than the buyer was willing to pay. Apparently private sector firms that are too big to fail are also too big to achieve that ultimate of neo-classical economics accolades: efficiency. Or maybe it is efficient to foreclose and sell for less rather than halt foreclosure and sell for more? In that case, is efficiency all that we should care about?

Regular readers know that one recurring theme in this blog is that concentrated economic and political power in the private sector is as much a "problem" as an ineffective, inefficient guvment especially one that has been deprived of the funds needed to regulate a complex capitalist society based on commercial exchange and characterized in some sectors (like health and finance) by several types of market failure. Regular readers also know that as someone who grew up in a private sector family business, I expect  private sector employees and their managers to behave better than caricatures of mindless guvmint bureaucrats that populate cautionary tales about totalitarian guvmints.

It should also be noted that it was in a government court that the GMAC travesty was exposed and halted. I also deduce from the article that there are 27 remaining states that do not mandate a court judgement before a lender can take possession of a property (that is to say, they do not have this regulation) and that in those states foreclosures may be continuing unabated thanks to Mr. Stephan's very efficient, but highly unethical rubber stamp.

It's a problem when guvmint is always and everywhere perceived to be the problem. It makes it difficult to pass legislation that would protect homeowners, borrowers, small businesses, renters, consumers (all the people who fuel and benefit from economic growth and prosperity) from corporate abuse of political and economic power. Next thing you know, we're living in Potterville, instead of Bedford Falls.

In this case, there's definitely a problem. I don't think its the government, however (although as you can see  government helped by serving the papers and evicting the homeowners).

Broward Chief Judge Victor Tobin, who set up the county court's foreclosure system, said this is the first he's heard of this type of mistake. "From the court's point of view we have no way of knowing that someone sells a house unless they tell us," said Tobin. "The bank would first have to tell the lawyers and the lawyers would presumably ask the court for an order dismissing the case."

Let's hope it's also the last time Judge Tobin hears of this type of mistake. It sounds so simple doesn't it? In one case, the bank would have to do its job and tell the lawyers. The bank's lawyers would have to do their jobs and ask for a dismissal. In the other case, the bank would have to halt the foreclosure and sell the house to a willing and qualified buyer for a higher price than they will get if they foreclose. Complicated, yes? It's amazing how a taxpayer-funded bank bailout could be arranged almost overnight, but stopping an erroneous bank-initiated foreclosure of a taxpayer's home can take weeks or months (and thousand of homeowner dollars in legal fees, I'll bet).

In economics, we teach that firm size and market power can lead to monopolistic pricing that results in loss of consumer welfare. Most of that discussion, at least in intro courses, focuses on the monopolistic firm being able to set price higher than marginal cost (in a competitive equilibrium we would expect price to equal marginal cost). When a firm has sufficient market power to set price higher than marginal cost, consumers lose because they pay a higher price and they purchase less of the good. The higher price deprives them of money that could otherwise be spent on other goods and services. The above suggests that for large firms with concentrated economic and political power, monopoly rents might be the least of our worries. Far worse is that they appear to have the potential to inflict long lasting harm on people who lack the resources to hire an attorney to defend themselves from efficiently, but improperly,  processed papers and unreasonable seizure.

Just ask yourself, as I often do, was your last unpleasant encounter with a cell phone company, a cable television company, a credit card company, or a bank or was it with a government agency?  In my case, I'm sorry to say that some of the larger, more powerful parts of the private sector lose hands down.

As Luck Would Have It

Paul Krugman, Brad "Deling", and James Fallows have been blogging about how the rich are different from you and me (see here, here, here, and here, and now Mike the Mad (but pretty coherent) biologist here). It is an interesting confluence of chance events, for I have been reading Roland Benabou and Jean Tirole's very thought-provoking paper, Belief in a Just World and Redistributive Politics (subsequently published in the Quarterly Journal of Economics in 2006). Here's the abstract:

International surveys reveal wide differences between the views held in different countries concerning the causes of wealth or poverty and the extent to which people are responsible for their own fate. At the same time, social ethnographies and experiments by psychologists demonstrate individuals' recurrent struggle with cognitive dissonance as they seek to maintain, and pass on to their children, a view of the world where effort ultimately pays off and everyone gets their just deserts. This paper offers a model that helps explain: i) why most people feel such a need to believe in a "just world"; ii) why this need, and therefore the prevalence of the belief, varies considerably across countries; iii) the implications of this phenomenon for international differences in political ideology, levels of redistribution, labor supply, aggregate income, and popular perceptions of the poor. The model shows in particular how complementarities arise endogenously between individuals' desired beliefs or ideological choices, resulting in two equilibria. A first, "American" equilibrium is characterized by a high prevalence of just-world beliefs among the population and relatively laissez-faire policies. The other, "European" equilibrium is characterized by more pessimism about the role of effort in economic outcomes and a more extensive welfare state. More generally, the paper develops a theory of collective beliefs and motivated cognitions, including those concerning "money" (consumption) and happiness, as well as religion.

The B&T article starts with a quote from Professor Melvin Lerner's book, The Belief in a Just World: A Fundamental Delusion:

"Individuals have a need to believe that they live in a world where people generally get what they deserve."

Here's the first paragraph of B&T:

International surveys reveal striking differences between the views held in different countries concerning the causes of wealth and poverty, the extent to which individuals are responsible for their own fate, and the long-run rewards to personal effort. American “exceptionalism,” as manifested by the widely held belief in the American Dream, is but the most striking example of this phenomenon. At the same time, ethnographic studies of the working and middle classes reveal that people do not come to these views as dispassionate statisticians. On the contrary, they constantly struggle with the cognitive dissonance required to maintain and pass on to their children the view that hard work and good deeds will ultimately bring a better life, that crime does not pay, etc., in spite of signals that life may not always be that fair. Psychologists have similarly documented the fact that most individuals feel a strong need to believe that they live in a world that is just, in the sense that people generally get what they deserve, and deserve what they get. When confronted with data that conflicts with this view they try to ignore, reinterpret, distort, or forget it—for instance, by finding imaginary merits to the recipients of fortuitous rewards, or assigning blame to innocent victims.

That last sentence got me thinking about the latest issue of American Whitewater, which contains Charlie Walbridge's semi-annual recount of whitewater deaths and near-misses.

"Maxine," you say, "what could possibly be the connection?"

Well, let me tell you.

After almost every whitewater death that involves a whitewater kayaker or canoeist, there is the obligatory postmortem in internet forums in which the details of the circumstances surrounding the death are shared, dissected, and eventually put to rest. The more experienced and expert the paddler, the more time spent analyzing what when wrong. You see, if an experienced, expert paddler who has run, say, the North Fork of the Payette, 50 times can be killed on it, it means anybody could be killed on it or on lesser rivers. But if the experienced, expert paddler can be found to have made some mistake, entering a rapid off-line, missing the micro-eddy at the top that helps set up for the drop, then we're all much safer. It just means we have to make sure we don't make the same mistake. And if he got  snagged on a barely underwater tree branch, well, then it was bad luck, but now we all know about it and we know to watch for such things in other rapids. Lesson learned. We're back in control.

The post-mortems almost always end with the obligatory "well, s/he (usually he) died doing something that he loved." You see how the impulse to find a silver lining is not squelched even by the ultimate loss? But it leaves us to wonder if the now deceased would have put on the river that day, had he known that the price of doing something he loved was his life? The economist in me thinks not. That's the tragedy of hindsight...we so often don't get to make the tradeoffs with complete information. It was a statistical risk, very small, but finite. And we like to believe that we can offset bad luck with good skills and effort.

The problem is that everyone has an unlucky day or sometimes it's just a minute or an hour, but it's enough to change our lives forever. If it happens on a river, your income won't save you, but in a lot of life, your income or the social safety net of the society you happen to live in, just might.

I recently performed an exercise where I added up all the times I could remember where I could have died. They included the time our (small) sailboat jibed and almost capsized in strong winds on a very cold December day. I know now (thanks to my whitewater experience) that we would have lasted maybe 90 seconds in the frigid water. There was the time the horse fell on me. There was the time I had cancer. And there are at least six other times that I can remember.

As you can see, there are at least nine reasons why I consider myself lucky. I don't imagine that any of these near misses resolved in my favor because of some special trait or ability that I have. Nor do I believe they resulted from any effort on my part. I  just   got    lucky.

I also got lucky at birth and that has affected my education, my income, and my life prospects.

I'll bet if you think about your life, you'll think of some lucky things that have happened to you. (And no fair claiming that having cancer is lucky (if you live) because of some "silver lining" like now you love your wife and kids more. That's just one of the ways we turn things around cognitively so that we end up getting what (we think) we deserve.)

Here's B&T again:

Data from the World Values Survey [Alesina, Glaeser, and Sacerdote 2001; Keely 2002] show that only 29 percent of Americans believe that the poor are trapped in poverty and only 30 percent that luck, rather than effort or education, determines income. The figures for Europeans are nearly double: 60 percent and 54 percent, respectively. Similarly, Americans are about twice as likely as Europeans to think that the poor “are lazy or lack willpower” (60 percent versus 26 percent) and that “in the long run, hard work usually brings a better life” (59 percent versus 34–43 percent [Ladd and Bowman 1998]). Large disparities in attitudes also exist within Europe, especially between OECD and Eastern European countries [Suhrcke 2001].

And here's a figure they reproduce from a paper by Alesina et al. (2001):

B&T cite ethnographic research that suggests that working and lower middle-class workers exert effort to maintain a belief that effort, hard work, and good deeds ultimately pay off, that people get what they deserve. They note that the corollary is also taken as true: that what they get must be what they deserve. They note that this often combines with a perception that the United States is a highly mobile society with few social and economic barriers to achieving higher status. This last despite evidence they cite to the contrary.

Here is one particularly poignant excerpt they provide from a qualitative study:

Typical is this statement by Maria, a very poor cleaning lady interviewed by Hochschild (1996):“Once, Maria wonders if executives deserve their $60,000 annual salary: «I don’t think they do all that [much] work, do you? Sit at their desk —they got it easy». But she suppresses the thought immediately. «Well, maybe it is a lot of work. Maybe they have a lot of writing to do, or they have to make sure things go right. So maybe they are deserving of it”».

B&T also cite psychologists' findings that we humans have strong tendencies "to explain the behavior and outcomes of others by underlying personal attributes rather than external circumstances or luck." Coupled with this is "excessive confidence that they, and others, can affect their own environment and, ultimately, their own fate." As with my whitewater example, this provides an "illusion of control."

The paper is an excellent example of work by economists aimed at expanding the scope of economics to include psychological and sociological dimensions of human behavior and to address issues of justice. The authors note in their conclusions that there is no sure way of knowing whether the uniquely American cultural beliefs and attitudes about effort, chance, and just deserts are net-harmful or net-helpful.

Systematic under-estimation of the role of chance in whitewater boating, probably helps most of us to stretch and improve our skills and abilities. We get better. Systematic under-estimation of the role of chance in social and economic outcomes almost certainly helps us as a nation to stretch, improve, and grow, but it hinders us, too. Because of our beliefs, we are unable to come together politically to construct an optimal safety net, one that would enable families to rebound from an illness or injury or from a job loss without having to sell the farm (or house or business) or to pay the ultimate price of death or permanent disability. And we are unable to agree on how to regulate or limit concentrated wealth and power because we apparently confuse it with ability and productivity, even when there is massive evidence to the contrary in some sectors.

One reason that income disparities grow is that we possess an inherent tendency to justify them, to chalk up to effort that which is in some measure and sometimes largely a long series of lucky happenstances that start at birth. The problem is that occassionally something happens that forces us to notice and not justify. A major recession. A financial crisis. A major bailout of the guys to ran us off the road. A high unemployment rate. When it happens, some in the middle and at the bottom start noticing that the rich are different from you and me.

What B&T do not discuss is that some day Maria (quoted above) and others like her, who show up on time, work hard, and pursue the American dream, will figure it out. They'll see that the deck is stacked against them. They'll look at investment bankers and their kids and they'll figure out that there's no percentage in a hard day's work, for them or for their kids. They won't put it in quite these words, but they will be struck by the obsessive fear lawmakers and some economists appear to have of investment bankers' alleged backward bending labor supply curve. Specifically, they will be struck by how that fear  gives rise to a near rabid reluctance to tax those same investment bankers. Investment bankers whose speculative activities destroyed  working and middle class families' jobs, neighborhoods, and dreams, and saddled them with mortgage debt and bank and credit card fees they can't afford.

Maybe those at the bottom and middle of the economic pyramid can't afford to withhold their effort from the labormarket, but they can vote. And they can certainly come to view the employment contract as adversarial. They can shirk, they can become dishonest in other ways, they can sabotage, they can start to act as though all that matters is money and how much of it you have, not how or whether or not you earned it...all fairly rationally and (within the prevailing moral climate they have seen rewarded at the top) morally. We can only hope that instead they only unionize and collectively bargain.

The fact that we adapt to inequities by telling stories that justify them doesn't make them fair.

As luck would have it, there's something we can do now that would be a good first step toward a renewed American dream that everyone gets to participate in. There's an income tax reduction about to expire. We could allow it to expire for the wealthiest Americans (those making more than $250,000), many of whom benefited from the bank bailouts either directly (if they work in the financial sector) or indirectly through the support their retirement and investment portfolios received from various Federal Reserve policies aimed at saving banks and inflating assets. Let's take a chance and reward hard work and honest effort for a change. Let's keep the tax break for the working and middle class and let it expire for those who have already had more than their fair share of taxpayer-provided largesse.

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Papers cited by B&T in quoted material above:

Alesina, A.  E. Glaeser, E., and Sacerdote, B.(2001) “Why Doesn’t the US Have a European-Type Welfare State?” Brookings Papers on Economic Activity, Issue 2, 187-277.

Hochschild, J. (1981) “What’s Fair? American Beliefs about Distributive Justice”. Cambridge, MA: Harvard University Press.

Ladd, E. and Bowman, K. “Attitudes Towards Economic Inequality,” American Enterprise Institute Studies on Understanding Economic Inequality.

Felix Salmon Optimistic About Warren Appointment

Maybe my own optimism is not misplaced. Here's Salmon:

As of Monday, when she moves in to her new office and already has lunch scheduled with Tim Geithner, Warren is going to be a fully-fledged member of the White House economic team, meeting with the president and the rest of his economic advisors on a regular basis. Yes, her portfolio will specifically be consumer protection, but she’ll be able to advise in any area where she feels she can add value.

She was also clear that she has the authority to get the Consumer Financial Protection Bureau up and running as quickly as she can — to hire people, set the budget, and so forth. She wouldn’t be drawn on the question of appointing a director, or whether she has any desire to return to Harvard. But she was clear that she was excited “to make this shift from being on the outside to being on the inside”

Read the full article here.

Angry Bear Blog Sends Us to the Best of Elizabeth Warren

Watch it here.

Elizabeth Warren. Maybe!

From the NY Times:

President Obama is expected to announce in a Rose Garden ceremony Friday afternoon that he is appointing Elizabeth Warren to head the Consumer Financial Protection Bureau as his assistant. But hours before the formal announcement, Ms. Warren issued a folksy message on the White House Blog about why she is taking on the job.

I'm not sure how one achieves "folksiness" in the NY Times' view, but I conclude it must be by referencing one's grandparents. There is little that is folksy about her post to the WH blog.

President Obama understands the importance of leveling the playing field again for families and creating protections that work not just for the wealthy or connected, but for every American. The new consumer bureau is based on a pretty simple idea:  people ought to be able to read their credit card and mortgage contracts and know the deal.  They shouldn’t learn about an unfair rule or practice only when it bites them—way too late for them to do anything about it.  The new law creates a chance to put a tough cop on the beat and provide real accountability and oversight of the consumer credit market.  The time for hiding tricks and traps in the fine print is over.  This new bureau is based on the simple idea that if the playing field is level and families can see what’s going on, they will have better tools to make better choices.

Or maybe "folksy" is code for "language everyone can understand." If so, we should all be more folksy. It would go a long way toward improved market efficiency and equity.

This and Jon Stewart's Rally to Restore Sanity have provided me with the first real audacious hope I have felt since the turn of the century.

Addendum: It appears I may have misread this. Here's Yves Smith suggesting this is a way to sideline Warren. I'll continue to hope it's a way to get her in the back door. If not, then shame on BHO. Where's the audacity? Where's the change?

Dr. Frances Kelsey and Another Pharma "Lemon"

The NY Times runs this article which is related to my last post about pharmaceutical research and the "lemon-like" market in which pharmaceuticals trade. It is also related to an earlier post in which I described how elixir of sulfinilamide helped lead to tougher FDA rules.

Dr. Frances Kelsey played an important role in the latter episode and in the thalidomide episode that left many European children with serious birth defects (but not US children thanks to Dr. Kelsey).

Here's an excerpt:

She arrived at the F.D.A. in 1960 as part of a new cadre of scientists who had begun insisting that drugs show clear evidence of effectiveness as a condition for approval, even though Congress had yet to grant the agency explicit authority to enforce that. Drugs could be sold 60 days after their makers filed information with the agency as long as it did not object; companies routinely sent new remedies to doctors and asked them to try the medicine in patients. Such testing was uncontrolled and entirely anecdotal.

Dr. Kelsey demanded better tests for thalidomide. She also distrusted Merrell, a company that had a history of confrontations with the F.D.A. She soon discovered that Kevadon had been linked in Europe with reports of nerve damage — reports the company had failed to provide her.

“I had the feeling throughout the day,” she wrote after a meeting with company executives, “that they were at no time being wholly frank with me and that this attitude has obtained in all our conferences, etc., regarding this drug.”

Company officials complained about Dr. Kelsey to her superiors, who supported her. When evidence became irrefutable that Kevadon caused horrendous birth defects, the company quietly withdrew its application.

Merrell executives had been insisting that “I was depriving people of this thing,” she said in the recent interview. “And then when it happened, I was so relieved to get them off my back. Amazing.”

Please read the entire article and meditate as I often do on how often large and largely unfettered private interests pose a much greater threat to people than a government that is charged with regulating those interests.

Hat tip to Ecrive.

Pharmaceutical Lemons

Yves Smith sends us to Howard Brody who describes a paper by his colleague,  Donald Light, a medical sociologist who "delivered [a paper] recently at the American Sociological Association annual meeting in Atlanta, August 17 (session 487), entitled, "Pharmaceuticals: A Two-Tiered Market for Producing 'Lemons' and Serious Harm."

Here's Light:

"[T]he pharmaceutical market for 'lemons,' differs from other markets for lemons in that companies develop and produce the lemons. Evidence in this paper indicates that the production of lemon-drugs with hidden dangers is widespread and results from the systematic exploitation of monopoly rights and the production of partial, biased information about the efficacy and safety of new drugs. The institutional practices differ profoundly from car manufacturers working tirelessly to produce safe cars but inadvertently discovering a serious problem, like Toyota discovering its sticking accelerator problem in 2009. The massive reaction, Congressional investigations, and recalls [in the Toyota case] involved less than 1/10,000 as many deaths as are attributed to prescription drugs every year."

It's always thrilling to see a sociologist using economic principles and concepts. In this case, the underpinnings of the paper are George Akerlof's (2001 Nobel Memorial Prize in Economic Sciences) seminal 1970 paper The Market for Lemons: Quality Uncertainty and the Market Mechanism. 

I only wish that Light had looked a bit farther afield than the recent Toyota accelerator problem before asserting that "The institutional practices differ profoundly from car manufacturers working tirelessly to produce safe cars but inadvertently discovering a serious problem." Specifically, I wish he had considered the 1970's Ford Pinto case. It is a classic example of the abuse of cost benefit analysis unfettered by ethical considerations since the "fix" for the problem of fiery death/injury from rear-end collisions was estimated at only $11/car. Oddly enough, even in the absence of moral sentiments, it's hard to see how one could conclude that because the total costs of a fix exceeds the total imputed dollar value of deaths and injuries averted, one should disregard the rather low marginal cost ($11/Pinto) to buyers who presumably would be willing to pay some amount for a decrement in fiery mortality/injury risk to themselves and their families. I have to think that (assuming only money matters here) the right calculation would involve buyers' willingness to pay for a decrease in risk coupled with the likely contraction in demand from the $11 dollar increment in price (along with the expansion in demand from the safety improvement). Then the correct (purely monetary) comparison would be between the resulting change in profits and in reduced costs of litigating liability claims, yes?

Seems almost like a corporate death panel, doesn't it? But I digress.

I concede that car safety is probably different from drugs safety, but I don't share Light's opinion that the "institutional practices" of the two industries differ that much. And that's the problem. Our legal, moral, and governmental institutions aren't really designed to deal with the causal and scientific uncertainty that characterizes the drugs industry.

It's much easier over time to draw an evidence-based causal link from car crash/failure to fiery death-watery grave-family of five killed on turnpike as such incidents happen repeatedly. Car crashes have the added advantage that when due to faulty equipment they tend to be nondiscriminatory, i.e., they don't just kill the already sick and infirm. They kill kids, young adults, and the middle-aged. All are groups that we can be reasonably certain were healthy and would have lived in the absence of the car crash.

If a car bursts into flame with higher than average frequency when compared to similar cars in similar crashes, it suggests a causal link between a specific car and the fiery outcome. If that car also happens to place its gas tank differently (closer to the rear of the car) than other similar cars and the gas tank ruptures with higher frequency than other similar cars in similar accidents, then it should be possible within less than seven years to conclude with some confidence that the car is the problem and it should be fixed. One can haggle over who pays, but it should be fixed.

Causal links between drug/device use and death or injury are harder to establish partly because people who take prescription drugs or use medical devices are...well...sick and (often) old. Many of them have several comorbidities which place them at higher risk for negative health sequelae and that make it difficult to know for sure what exactly caused them to have, for example, a heart attack.

A randomized controlled trial (RCT) can be helpful since (if the randomization is successful and if selection to be randomized and attrition from the trial are random in both experimental and control groups) we can compare similar people's death rates or heart attack rates. The problem is that when randomized controlled trials are designed to test drug efficacy, they frequently exclude those who are very ill and those with multiple comorbidities. However, when a drug or device is marketed, these same restrictions often do not apply.

The point here being that absence of evidence of elevated risk in an RCT does not guarantee that the risk is not there, because of the selection of relatively healthy people to participate in such trials. (Note: this is not an essay against RCTs, this is an essay about how information from a well-designed RCT needs to be subjected to critical review and interpretation.) A second problem with the types of RCTs conducted for drug approval is that they are designed to be large enough (i.e., to have enough people in the treatment group and the control group) to detect clinically meaningful differences in treatment response between the two groups. They are not designed and therefore are often not large enough to identify low frequency, high severity adverse side effects. When combined with conventionally abused methods of statistical inference, this last can be lethal (literally).

Let's say that you design an RCT with sufficient statistical power to detect a clinically meaningful difference in some outcome like symptomatic pain relief and let's say that requires about 5,500 people in your study. Half are treated with the new drug, half with an existing drug. . Now suppose that while you're conducting this study, you notice that 5 of the treated group develop a myocardial infarction (heart attack) while only one of the untreated group does. Should we be concerned that the drug in question poses elevated risk for heart attacks?

Let's take an actual case: Vioxx, a Cox-2 inhibitor manufactured by Merck that offered the potential for pain relief without the negative gastro-intestinal side effects associated with non-steroidal anti-inflammatory drugs (NSAIDS). (For most of the following discussion I draw on Ziliak and McCloskey's far superior treatment of this topic.) In the RCT of Vioxx against Naproxen Sodium (Aleve) reported in the Annals of Internal Medicine, there were roughly 5,500 individuals with osteoarthritis enrolled, roughly half in the treated-with-Vioxx group and half in the treated-with-Naproxen group. Five of the Vioxx group were reported to have experienced a heart attack, but only 1 in the Naproxen group.

The p-value associated with the 5 to 1 difference was .20. The authors of the report followed medical journal (and, unfortunately, many researchers') convention in concluding that the absence of "statistical significance" (because it exceeded a conventional (but arbitrary) threshold (p=.05)) indicated that the difference was a "null" finding. By "null finding" I mean that they concluded that there was no substantive difference in heart attack rates between two groups, despite the whopping 5 to 1 difference.

One problem with using p-values as the sole determinant of the importance of a research finding is that a p-value can be made smaller (thereby achieving statistical significance) simply by increasing the sample size. So if the trial had included 550,000 people and we observed 500 heart attacks among the Vioxx group and 100 among the Naproxen group, this 5 to 1 elevation in risk would have achieved statistical significance. Conversely the p-value can be made larger by decreasing sample size. If one makes a p-value smaller by adding to sample size (with no change in the relative differences between the two groups) one can then claim "statistical significance." If one makes a p-value larger by reducing one's sample size (without altering the relative difference of the two groups' outcomes), I'm sorry to say that one can almost always get away with claiming that there is no difference between the two groups, despite the fact that one may have insufficient statistical power to make any such claim (this is also known as a Type 2 error).

As Ziliak and McCloskey repeatedly emphasize: size matters. The size of the effect coupled with the potential severity, not some arbitrary and sizeless threshold of statistical significance, should determine how we decide if a difference matters or not.

In the case of the Vioxx study, it turned out that the difference did matter. In fact, it later came to light that the difference in heart attack risk between Vioxx takers and Naproxen takers was 8 to 1, not 5 to 1. According to the New England Journal of Medicine, three observations were suppressed by Merck. Had the 8 to 1 difference been reported, it would have tipped the statistical-significance-mindless-use-of-p-values scale to p<.05 and the authors would no longer have been able to pretend that the heart attack difference was a null finding.

Scientific uncertainty is why we use statistical inference to help us interpret the results of a scientific study. In the above example, two things stand out. First, the journal's editors and reviewers were content to accept the author's conclusion that a 5 to 1 difference did not rise to a level that would require further investigation. At least, not before the article was published. The Vioxx case is an example of how scientific uncertainty combined with a rather laissez-faire approach to statistical inference can lead to what I think (based on Brody's blog) Light calls a "lemon" drug.

But lemon drugs are different from lemon cars in other ways besides causal and scientific uncertainty. When a car is a lemon, nobody benefits from driving it. No matter who owns it, it breaks down, it explodes on impact, it costs the owner a fortune in repair bills and, sometimes, it costs the owner her job (if she's late for work repeatedly due to car failure).

When a drug is a lemon (at least in cases like Vioxx), some people actually benefit from taking the drug. Others pay the ultimate price for pain relief. Many drugs have this characteristic, benefiting some, harming others. Sometimes docs can guess pretty accurately who will benefit and who will be harmed. Unfortunately, drugs manufacturers spend a lot of money telling docs about drugs they manufacture. As with Vioxx, they have strong incentives to shape the information in ways that benefit the manufacturers and that misrepresent the safety of the drugs. Instead of leading private interests to a publicly beneficial result ("as if led by an invisible hand"), the self-interest of drugs manufacturers can lead to less benefit. But how are we to evaluate this?

80 million people took Vioxx resulting in $2.5 Bn in annual sales. Eric Topol, writing in the New England Journal of Medicine, puts the possible number of Vioxx deaths at 160,000. Of course, it could be much higher. The prescriptions were written for many people who were most likely older and sicker than those who were screened for participation in the RCTs. That means that heart attack risk could have been higher than 8 to 1 in "the real world." Notice how high severity, small probability events can become big problems with large losses when 10,000,000 prescriptions a month are being written. 

Institutions matter. The lawsuits cost Merck nearly $5 Bn. Regulation clearly has to have a role in policing a market where lemons can harm people, especially markets where lemons are complex as are the causal pathways. But there are several other messages that I believe the Vioxx episode sends us. One is that science isn't science when arbitrary thresholds derived from a dominant, but possibly inferior, framework for statistical inference are mindlessly accepted as indicators of the presence or absence of clinically or socially important effects. This is little different from Ford using cost benefit analysis without ethical consideration of the "recommendations" of the analysis (nor as far as I can tell a real understanding of the welfare economics that underlie it). 

Another message from the Vioxx scandal is that we as scientists, physicians, and ethicists must figure out how to quantify and communicate competing risks so that consumers (and their physicians) can make informed decisions about drugs that both help and harm. For each person who suffered a heart attack from Vioxx, there were many more who benefited from the pain relief. How are policy makers to evaluate this?  A purely utilitarian perspective would trade off quality adjusted life years gained for the many against the lives lost of the few. This seems unsatisfactory and not unlike making decisions based solely on net benefits calculated from a cost benefit analysis or a p-value from an RCT. What should a new framework look like?

A final message is that we consumers don't get younger or healthier over time. We're the ones most likely to be affected by side effects not captured in the RCTs that lead to drug approval. We can increase the size of drug trials, but it's not clear that the added expense is a wise use of societal resources.  A pharmacologist friend of mine once advised me never to take any new drug for which there was a close substitute that had been on the market for at least 5 years. Maybe if we all adopted that policy, the incentives to create new copycat drugs would be substantially reduced and the risks with them.

Pharma is like finance in that the opportunities for "innovation" that yield positive (but sometimes quite small) marginal benefit to most, great harm to some, and great profit to the innovators are rampant. Information asymmetry is compounded by causal and scientific uncertainty. Causal links are difficult to establish. Not all risks can be identified and managed in timely ways. There are unknown unknowns even after the results of RCTs are in and drugs have been approved. The risks for us as consumers are to our health and well-being, both from the negative sequelae of unforeseen side effects and through the distortions in manpower and capital that are drawn into a sector whose output may not yield benefits commensurate with its costs.

The Possibilities of Happiness

Before I left for 10 days of paddling around a lake in my sea kayak, Uwe Reinhardt had posted two excellent blogs describing shortcomings in common conceptualizations of welfare economics, here and here. I strongly recommend that you read both blogs and a paper he has very kindly provided with the second blog. I want to expand a bit on what Reinhardt has said because I think this is something that non-economists struggle with. I'm then going to attempt to relate it to John Rawls' conceptualization of justice as fairness.

I'm going to start by walking you through the following graph adapted from Reinhardt's article, Can Efficiency in Health Care Be Left to the Market?, a comment written in response to Kenneth Arrow's Uncertainty and the Welfare Economics of Medical Care. It is nearly identical to the one he provided in his recent NYT blog.  

Source: Uwe Reinhardt, Can Efficiency Be Left to the Market? In Kenneth Arrow and the Changing Economics of Health Care, Duke U Press, 2003.

The graph takes a form that is fairly common in economics. It is often used to depict a two good or two person world. The curve is often seen in intro econ textbooks as a production possibilities curve where it represents all possible combinations of the (two) goods that could be produced from a fixed set of resources. A similar graph, like that above, can be used to depict all possible combinations of (in this case, two people's) happiness (sometimes called "utility") that could be produced from available societal resources. As is frequently the case and without too much loss of generality, we have simplified by assuming a two-person world, Person A and Person B, among whom the available pool of happiness is to be divided. (Some of you will already be seeing at least one potential flaw with this, but bear with me.)

Now suppose that you are an economist and you believe that 1) happiness is difficult to measure and 2) it is difficult to compare the happiness of A to that of B. Let's therefore imagine that corresponding to each point on the curve is a certain distribution of national (in this case two person) resources. (Each possible distribution of resources could be represented by a straight line connecting W and Z with W representing 100% of national resources going to B (and 0% to A) and Z representing 100% of national resources going to A (with 0% going to B.)  I think it would be uncontroversial under these conditions to assert that the share of national resources (e.g., output, education, health care) a person receives provides a rough indicator of relative happiness, i.e., the larger the share you receive, the happier we would expect you to be. We could call it an "indirect happiness function." (Some of you will be quick to point out that there is not a very good correspondence between income and happiness, but bear with me, please.)

At point W, B is a very happy person (or at least rich in terms of resources and the positive sentiments that may accompany this state), A not so much. At Z, A is a very happy, resource-rich person and B is the person left out in the cold.

The curvature of the happiness frontier that connects W and Z reflects the idea that the rate at which happiness increases (decreases) as one's share of resources increases (decreases), decreases (increases) as one holds more (fewer) resources. Think about someone with very low income, low access to education and health care, say person B at a point just shy of Z. The curvature is rather steep there, reflecting that a small increment in B's share of resources when B doesn't have very much will produce a much larger gain in B's happiness relative to the loss of happiness that A experiences. As B's happiness (and share of resources) gets closer to W, the curve flattens, reflecting that even large increases in resource-share produce relatively smaller increases in happiness for B relative to rather steep reductions in happiness for A. The converse is true for A who at W is experiencing very large losses in happiness (and presumably resources) with each of B's small gains in happiness and share of resources.

As Reinhardt has already pointed out, all points on the curve are Pareto efficient. If the distribution of happiness is at, say, point D (or any other point on the curve), we cannot move in any direction along the curve without making either A or B less happy.  Only if we are at a point inside the curve is it possible to move to a place where at least one person is happier without the other person being made less happy.  From point C, if we move to point G, we make B happier, while A remains as happy as she was before the move. (If you doubt this, print the above and sketch in lines from these points to the two axes and note how A and B's happiness changes.)  If we move to point H, we make A happier, while B remains as happy as before. If we move to any point on the happiness possibilities curve that is bounded by points G and H, both A and B will be happier than they were at the Pareto inefficient point C.

Movement from C to anywhere between G and H seems pretty uncontroversial. After all, who wouldn't agree that if we can rearrange output or education or health care or anything else that contributes to happiness in ways that make no one less happy and make at least one other person happier, this is a Good Thing. The problem with Pareto efficiency arises if instead of being at, say, point E, where A and B have equal shares resources (and presumably equal happiness), we are instead at point D. Point D is Pareto efficient, but B has a near monopoly on both happiness and resources. Yet, among economists and some politicians, point D is preferred to point C because it is efficient.

As a thought experiment, imagine that at point D, A does not have enough income to attain adequate nutrition or health insurance, that A's life is at risk at point D. Surely that should matter, yes? Or imagine that point D was arrived at because B was an investment banker whose self-dealing behaviors precipitated an economy-wide downturn that also shifted inordinate amounts of wealth in B's direction. Does a rule based on not allowing A to be made better off at B's expense make sense here?  Does a Kaldor-Hicks rule that requires A to compensate B for a move that improves A's welfare at B's expense make sense here? Should we be reassured to learn that competitive markets guarantee that trade and production will arrive at Pareto efficient points without consideration of how the initial or any subsequent distribution of resources has been achieved? How reassured should we be if markets aren't competitive? What if highly unequal distributions, such as D, cause the loser to implement involuntary income transfers, i.e., crime rises, trust is lost, A and B retreat into armed camps? Are the happiness of A and B, independent or are they interdependent?

Reinhardt makes the point in his paper that inefficient, but more equitable, point C may well be viewed as superior to efficient, but highly inequitable point D. A society's decisions about this may well hinge on the stories it tells itself about A and B. If B is productive and A is slothful, then D may seem right and fair.  If A is the producer and B is the slacker, then D will seem even more unfair than it might if both were equally productive or equally slothful. Given that there is likely to be some underlying heterogeneity in productive capacity between A and B, how are we to make such judgments? Would we want to base it only on productive capacity?  How would we choose the "right" fair but inefficient point that is preferable to an efficient, but possibly unfair point, like D?

But there's more. It's here that the correspondence between resource share and happiness becomes difficult. Assume that C-E is a 45 degree line through the origin that represents equality of resource shares. Then any movement from C to the arc bounded by G-E requires that more resources go to B. Similarly, movement from C to any point on the arc bounded by E-H requires that more resources go to A. Yet both movements result in higher happiness for both individuals. What should guide a decision to move from C to the G-H arc and where on it should we be?

One of the things about the above diagram that puzzled me from the very first time I saw one like it was: why that shape? Surely over some range, particularly when we're graphing the happiness of two individuals, it must be possible that the happiness of another delights us, yes? Clearly, yes, when the other is a near and dear friend or relative, but surely also for those more distal in our affections, too. Is happiness always a zero sum game at the frontier?

Here's Adam Smith, very first sentence of Theory of Moral Sentiments:

How selfish soever man may be supposed, there are evidently some principles in his nature, which interest him in the fortune of others, and render their happiness necessary to him, though he derives nothing from it, except the pleasure of seeing it.

There are economic models of altruism, but for me most are very unsatisfying. For one thing, I prefer to live in a world where I don't have to step over bodies or live behind gate houses and fences. I'm pretty sure that requires me to care about the welfare of people other than my immediate family and descendants and probably on levels that are not purely instrumental, reciprocal, or utilitarian. For another, it seems to me to be highly inefficient to create a society in which the absence of social and health insurance allows uncertainty to rob the able and talented of both entrepreneurship, innovation, and their worldly goods when bad luck, bad choices or bad bankers result in individual or society-wide downturns. These sentiments are not selfless, as altruism is often viewed. I derive something beneficial from living in an economy and a society in which we all share in some to be determined distribution of resources upon which depends our joint and individual happiness. I may give up some resources or output, but I may gain trust, safety, community, some free time, and possibly more innovation depending on how free time is used.

On the other hand, I might not benefit at all from improvements to others' well-being. Sometimes it's just the right, fair, just thing to do.

So what would the above diagram look like where over some range, A delights in or benefits from improvements to B's lot in life and vice versa? Here's something from John Rawls' Justice as Fairness: A Restatement (p. 62) (with apologies for the black background). (See also Atkinson & Stiglitz, Lectures on Public Economics, 1980, McGraw-Hill, page 338 and accompanying discussion.)

Source: Rawls, J, Justice as Fairness: A Restatement, Harvard U Press, 2003, p. 62-63.

In this diagram, person B (vertical axis) is now a representative person from the Least Advantaged Group (denoted LAG) and person A (horizontal axis) is now a representative person from the Most Advantaged Group (denoted MAG).This is a social welfare function or happiness possibilities curve with both axes representing a share of primary goods allocated to either MAG or LAG. The index of primary goods represents "a person's prospects of income and wealth over a complete life" and includes 1) basic rights and liberties such as freedom of thought, conscience, and the rest; 2) freedom of movement and free choice of occupation in a climate of multiple diverse opportunities; 3) powers and prerogatives of offices and positions of authority and responsibility; 4) income and wealth in an economy or social context where both have exchange value; and 5) social institutions that support self-respect, the worth of all persons, and the ability of individuals to advance their own ends with self-confidence.  Note that this is a much richer list than simply assuming that a person's share of national resources adequately indexes their utility. It captures political and institutional aspects of society that also influence individual well-being. For this reason, it is richer than the Pareto efficiency criterion that dominates economic assessments of welfare. The curve lies below the 45 degree line from the origin because the initial distribution of resources (or primary goods) favors MAG.

Rawls provides one possible framework for choosing an inefficient point C, that lies somewhere within the happiness frontier in the first graph and not necessarily on the 45 degree equality line.

The main difference between this and Reinhardt's graph is that from O to D, the shares of primary goods and the happiness of both persons or groups (since each person is representative) are increasing together. Point D is the point at which happiness is (efficiently) maximized subject to an equal justice constraint denoted by the horizontal lines. (Think of the lines as the highest attainable jointly produced happiness that also provides the highest level of primary goods to LAG.) The justice constraint derives from Rawls' difference principle, which tolerates inequalities as long as they benefit LAG.

Point B, which represents a higher level of total happiness or utility than point D in Rawls' graph, is the utilitarian or Bentham bliss point. B is the point that standard neoclassical economics and economic welfare analytics would identify as optimal because total happiness is at it's highest point. N is the Nash equilibrium, which in this case can be thought of as the happiness or utility maximizing solution you would get (in this world in which output and utility depend on cooperation between LAG and MAG) if you did not have the justice constraint (that happiness/utility be maximized subject to making LAG was well of as is possible). Point F is what Rawls calls the "feudal point" where all the utility (and presumably resources) are concentrated with MAG. The important thing to note about F is that MAG is extremely well-off, LAG is extremely disadvantaged, and societal happiness (and output) could be higher if primary goods were redistributed in such a way that LAG and MAG could move back to B. This last is important. It must be so if B is a true maximum of total utility.

I occasionally hear rhetoric that seems to suggest that the more resources are concentrated at the top (among the MAG), the better off we will all be (since it will trickle down upon us all). When Adam Smith was writing about the nature and causes of the wealth of nations, he was comparing point F to a point that was approaching point B from F, i.e., national wealth (and presumably total utility/happiness) was growing as commercial exchange (when not impeded by mercantile interests) and the division of labor reshaped the distribution of national income to favor LAG a bit more.

Also note that the Rawlsian bliss point, D, is not a point at which both individuals share equally in primary goods (or presumably in equal utility or happiness). That point would have to fall on the 45 degree line from the origin. Equality would result in both very low happiness for both and also very low national output.

For Rawls, the rising portion of the utility/happiness curve (which I'm assuming tracks a similarly shaped national output curve) results from cooperation in production and in each other's happiness. This might be because LAG delights in improvements to MAG's welfare and vice versa or it might be because both MAG and LAG benefit in instrumental ways from improvements to each others' welfare. For example, in the kind of world that libertarians and free marketers believe we live in, MAG may be gifted with entrepreneurial skill or inventive talent. MAG creates jobs and invents cures for cancer (MAG does not capture monopoly rents while doing these things). LAG benefits from this so LAG's happiness increases with MAG's contribution to jointly produced output.

There are other reasons why we might observe interdependent happiness and productivity. MAG and LAG might be related or they might be friends. They might be neighbors and LAG is about to have her house foreclosed. The deterioration of lot and house as it stands empty will affect the price of MAG's house. This is an externality of LAG's misfortune that negatively impacts MAG. Externalities are important sources of interdependent utilities that are often ignored, underestimated, or assumed away in economic analysis. At a minimum, cooperation would build and reinforce trust and reduce transaction costs. It almost certainly reduces crime and the costs associated with it as well as societal (and political) conflict, which benefits everyone.

Let me just make a final point for anyone with the fortitude to have read this far. Uwe Reinhardt has already described the ways in which "efficiency," a term with precise economic and scientific meaning, has taken on or perhaps has always implicitly contained value-laden meaning. The fact that it is almost always viewed as a Good Thing should prompt us to look at it more critically, particularly when we suspect we are moving over time to something like point D in the first graph above or point F in the second graph. But notice also that how we conceptualize productive effort and the way we draw our curves can shape the way we think about these problems. The first curve above requires that, unless one is in the interior of the curve, happiness is a zero-sum game, that I can only gain more happiness at your expense and you at mine. This problem will be amplified if we rather mindlessly assume that whatever point we happen find ourselves at is on that Pareto efficient frontier.

The second graph suggests that there is some range over which we can all gain in happiness and output if only we will cooperate.

Much of what passes for political discourse is really about where we as a society want to be on one of these curves and whether or not the curve accurately captures the utility/happiness "production process" of a society. I'm almost certain that it is cooperative over some range, much like that of any other production process. (Otherwise, there would be no competitive advantage to large corporations; all businesses would be small individual firms.)

The fact that over the last 30 years we seem to have been approaching feudal point F, where resources and whatever happiness it may afford go disproportionately to the most advantaged, should cause all of us concern. That the transfer has made the least advantaged even worse off should be reason to question the entire underlying Paretian and Kaldor-Hicks welfare framework, at least as currently conceptualized and taught.

As to the incomparability of individual utilities, I may not be able to compare MAG and LAG's utility directly, but I'm pretty sure that when MAG has most of whatever happiness money can buy (and the resources with which to buy it), we as a society have or will have a problem. If the resources were obtained by bankrupting LAG or suckering him into buying a house that LAG couldn't afford, then the problem is (or will be) even worse. If MAG has been in effect rewarded for that behavior or even held harmless, I suspect the problems may become far reaching and less readily remedied.

But my most concrete concern right now is that, just as we have elevated prudence and her handmaiden, "efficiency," above primary virtues like beneficence and her bedfellows, sympathy and fellow-feeling, so have we economists shaped our students' thinking and public discourse in ways that have contributed to growing income inequality in the US. I believe we have done this in part by how we draw and teach our curves.